Inventory

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Financial Accounting

Inventory

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Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.

1. Which inventory method will give the lowest cost of goods sold in an inflationary environment?

a. FIFO
b. LIFO
c. Weighted average
d. each method listed will give the same cost of goods sold

Check Your Answer
A. An inflationary environment means that costs are increasing. The lowest cost of goods sold will be from the first items being sold first because they have a lower cost. First items sold first is FIFO.
2. When a company operates in an inflationary environment

a. the company will have larger income using LIFO than FIFO
b. the company will have lower cost of goods sold using LIFO than FIFO
c. inventory will have a lower value under LIFO than FIFO
d. net income is always the same under FIFO and LIFO

Check Your Answer
C. An inflationary environment means that costs are increasing. The highest cost of goods sold will be from the last items being sold first, LIFO (b). When cost of goods sold is higher, ending inventory is lower. When cost of goods sold is higher, net income is lower (a.).
3. The company included $20,000 of goods on consignment that were being stored in the company’s warehouse in inventory reported on the balance sheet. As a result

a. inventory is reported properly
b. cost of goods sold is lower
c. income is lower
d. inventory is understated

Check Your Answer
B. Items on consignment are not owned by the company and should not be reported as inventory on the balance sheet. Inventory is incorrectly overstated. When ending inventory is overstated (too high), cost of goods sold is understated (too low) and net income is overstated (too high).
4. Lower of cost or market gives the most conservative value when applied

a. to inventory in total
b. to major classes of inventory and in total
c. to individual items
d. to cost of goods sold

Check Your Answer
C. The most conservative value is the lowest value. Applying LCM to each item will reduce each item that is lower than cost, which will give a lower value than if applied in total which allows items that have a lower market value to be offset by items with higher market values.
5. The lower of cost or market rule is applied to comply with

a. the principle of reliability
b. the historical cost convention
c. the principle of comparability
d. the concept of conservatism

Check Your Answer
D. LCM is applied to make sure that the asset inventory is not reported at an amount higher than expected future cash flows. This is done to be conservative. It is an estimate, which is not very reliable (a.) Using LCM, inventory is often adjusted to an amount different than historical cost (b.).
6. The difference in net income when using FIFO as compared to LIFO will be
minimized when

a. on average inventory is held for 30 days
b. on average inventory is held for one year
c. LIFO is used for tax purposes
d. LIFO is used for financial reporting purposes

Check Your Answer
A. When inventory sells quickly, there will be minimal difference in the first cost and the last cost of inventory still on hand. (c. & d.) do not cause the difference in income for LIFO and FIFO which is caused by inflation or deflation.
7. When beginning inventory is understated by $50,000 and ending inventory is
overstated by $20,000, net income will be

a. understated by $70,000
b. overstated by $70,000
c. understated by $30,000
d. overstated by $30,000

Check Your Answer
B. Beginning inventory too low will make cost of goods sold too low. Ending inventory too high will make cost of goods sold too low. Both errors make cost of goods sold too low by $70,000 which makes net income too high (overstated).
(Refer to the formula: BI + Purchases – EI = CGS)
8. Which of the following is an advantage of using FIFO?

a. it allows gross profit to be reported 100% accurately
b. it reports inventory on the balance sheet at approximate replacement cost
c. it always reports the asset on the balance sheet at the lowest amount possible
d. it always maximizes net income

Check Your Answer
B. FIFO will leave the latest purchases as inventory. The latest purchases are closest to replacement cost. Inventory methods are estimates and are not 100% accurate (a.) FIFO does not always give a lower inventory value or a higher net income, this depends on if the company is experiencing inflation or deflation.
9. Which method results in the highest cash flow when inventory costs are rising?

a. FIFO
b. LIFO
c. Weighted average
d. inventory methods do not affect cash flows

Check Your Answer
B. LIFO gives the lowest net income when costs are increasing because it gives the highest cost of goods sold. Lower net income leads to lower taxes paid which leads to higher cash flows. Moving costs from inventory to cost of goods sold does not change cash flows. The amount of taxes paid on reported income does impact cash flows.
10. When applying lower of cost or market and inventory is decreasing in value, net
income for the period will

a. be higher since reported cost of goods sold will be lower
b. be lower since reported cost of goods sold will be higher
c. be the same since lower of cost or market does not affect net income
d. be higher since the adjustment to market will occur when the inventory is sold due to the matching concept

Check Your Answer
B. Inventory that is decreasing in value must be decreased. When an asset is lower an expense occurs. This expense is not always called cost of goods sold, but it is always reported as cost of goods sold. Higher cost of goods sold gives lower net income. The adjustment is made when it is discovered the inventory is losing value (d).
11. A company sells one product. At the beginning of the year the company had 10,000 finished products in inventory at a cost to manufacture of $11 each. During the year the company manufactured 3 different batches of product consisting of 12,000, 14,000 and 8,000 units at a total cost of $135,000, $161,000 and $96,000 respectively in this order. During the year the company sold 41,000 units for $800,000 in sales dollars. Shipping costs are $0.30 for each product shipped. Compute the value of ending inventory and cost of goods sold for the period using

A. FIFO
B. LIFO
C. Average cost

Check Your Answer
First you must determine the cost per unit for each purchase. Divide total cost by total
quantity produced to get the cost per unit.

Batch Total Cost Quantity Cost per Unit
1 $135,000 12,000 $11.25
2 $161,000 14,000 $11.50
3 $96,000 8,000 $12.00

Shipping costs are a selling cost and are not part of the cost of the product.

Second: Put inventory in order and determine available quantity and cost.

Quantity Cost per  Total Cost
Beginning 10,000 $11.00 $110,000
Batch 1 12,000 $11.25 $135,000
Batch 2 14,000 $11.50 $161,000
Batch 3 8,000 $12.00 $96,000
Total Available 44,000 $502,000

Then compute cost of goods sold and ending inventory for each method.

A. FIFO First ones purchased are the first ones sold. Go down from the top until
you get to the total of 41,000.

Quantity Cost per  Total Cost
Beginning 10,000 $11.00 $110,000
Batch 1 12,000 $11.25 $135,000
Batch 2 14,000 $11.50 $161,000
Batch 3 5,000 $12.00 $60,000
Total Available 41,000 $466,000 =COGS

You only use 5,000 of Batch 3 because that is all you need to get you to 41,000 sold.

Once you have determined the cost of goods sold, ending inventory is always

   Available                       $502,000 see above
– Cost of goods sold      ($466,000)
= Ending inventory          $36,000

B. LIFO Last ones purchased are the first ones sold. Start at the bottom and go up
until you get to a total of 41,000 units sold.

Quantity Cost Per Total Cost
Batch 3 8,000 $12.00 $96,000
Batch 2 14,000 $11.50 $161,000
Batch 1 12,000 $11.25 $135,000
Beginning 7,000 $11.00 $77,000
Total Sold 41,000 $469,000 =COGS

You only use 7,000 of the beginning inventory because that is all you need to get you to 41,000 sold. Use enough to get to the total sold.

Once you have determined the cost of goods sold, ending inventory is always

   Available                       $502,000 see above
– Cost of goods sold      ($469,000)
= Ending inventory          $33,000

C. Weighted Average method: Use “Available” to get the average cost per unit

Total $ Available                $502,000 = $11.409
Total Quantity Available       44,000

Units sold                                     41,000
x Average cost per unit             $11.409
= Cost of goods sold                $467,769

Once you have determined the cost of goods sold, ending inventory is always

   Available                           $502,000
– Cost of goods sold          ($467,769)
= Ending inventory              $34,231

12. The company uses a periodic inventory method. The following information has been gathered to prepare financial statements:

Sales during the period $1,000,000
Beginning Inventory $200,000
Ending Inventory $225,000
Freight Out $62,000
Purchases $765,000
Purchase Returns $80,000
Admin Expense $300,000
Advertising Expense $50,000

Using the information provided, determine

A. Goods available for sale
B. Cost of goods sold
C. Gross profit %

Check Your Answer
Ignore operating expenses when computing inventory costs and cost of goods sold.
Freight out, administrative expense and advertising expense are operating expenses.

A. Goods available for sale: the total that could have been sold to customers this period

Beginning inventory                200,000
+ Purchases                                765,000
– Purchase Returns                   (80,000)
= Goods Available for sale       885,000

B. Cost of Goods sold:

Beginning inventory                 200,000
+ Purchases                                 765,000
– Purchase Returns                    (80,000)
= Goods Available for sale        885,000
– Ending inventory                    (225,000)
= Cost of Goods sold                  660,000

C. Gross Profit %:

Sales                                1,000,000
– Cost of Goods Sold      (660,000)
= Gross Profit                   340,000

Gross Profit                       340,000 = 34% Gross profit
Sales                                 1,000,000

13. The company’s inventory balance according to the physical count taken at the end of the year was $375,000. The accountant preparing the financial statements discovered the following:

a. On December 28th, $8,000 of goods were shipped F.O.B. destination to customers. The goods were received on January 2nd.
b. On December 28th, $6,000 of goods were shipped F.O.B. shipping to customers. The goods were received on January 2nd. The goods were included in the inventory
balance.
c. $12,000 of inventory on consignment was included in the inventory balance.

Gross profit based on the above inventory count was $600,000. Compute the correct
gross profit?

Check Your Answer
a. Inventory shipped FOB destination is stilled owned by the company until it is received by the customer. The customer received it on 1/2, so on 12/31 the company should include the amount as inventory. It was not included because it was not in the warehouse on 12/31, it had been shipped out.

Ending inventory must be increased by $8,000

b. Inventory shipped FOB shipping is owned by the customer on the date it is shipped. The inventory was included in the count and must be taken out of the ending balance.

Ending inventory must be decreased by $6,000

c. Goods owned on consignment are not owned by the company and should not be
included in the ending inventory balance.

Ending inventory must be decreased by $12,000

Total change to ending inventory is + 8,000 – 6,000 – 12,000 = decrease 10,000

Beginning Inventory
+ Purchases
– Ending inventory             (10,000)
= Cost of goods sold          +10,000

Ending inventory is less, so cost of goods sold is more

Sales
– cost of goods sold             +10,000
= Gross profit                       (10,000)

Cost of goods sold is more, and gross profit will be less

Previous gross profit            600,000
Lower Gross profit                 (10,000)
Adjusted Gross profit            590,000